Forsythe v. ESC Fund Management Co. (U.S.), Inc., C.A. No. 1091-VCL (Del. Ch. August 11, 2010), read opinion here. Among the five prior opinions in this case (all listed at footnote 1 of the decision), highlights of three are available here.
This is the latest in a long-running dispute involving claims by the investors of an investment fund formed as a limited partnership. Procedurally, the Court makes its analysis in the context of a Motion for Summary Judgment. The Court recognized many factual issues that prevented a ruling on many of the claims but nonetheless, granted in part and denied in part a Motion for Summary Judgment regarding the various claims of the parties against the managers of the fund. Most of the claims were governed by the terms of the agreement among the parties.
The key agreement among the parties contained an exculpatory provision that limited the liability of the general partner, special limited partner and investment advisor. The exculpation clause, in essence, only allowed the recovery of damages if the following could be established: “Bad faith, willful misconduct, gross negligence or material breach of the [agreement].” The detailed factual background provided by the Court takes up about the first 19-pages of the decision. For purposes of this brief and cursory highlight of the key parts of the decision, there were several affiliated funds that worked “side-by-side” with other funds. The overlapping and interfacing among the affiliated funds created some of the raw material for the claims. Of course, one of the reasons why the litigation began is because of the substantial losses suffered by the investors. Although the returns eventually “got back into the black,” the returns generated were “approximately $200 million below the returns generated by the lowest quartile of comparable funds.”
The Court found material questions of fact as to whether defendants acted in bad faith or with gross negligence. Bad faith was defined as occurring when a “fiduciary intentionally fails to act in the face of a known duty to act, demonstrating a conscious disregard for his duties." (citing Lyondell Chem. Co. v. Ryan, 970 A.2d 235, 253 (Del. 2008)). Gross negligence was defined as including “conduct that constitutes a reckless indifference or actions that are without the bounds of reason.” (citing McPadden v. Sidhu, 964 A.2d 1262, 1274 (Del. Ch. 2008)).
Referring to the language of the agreement addressed in a prior decision from the Court of Chancery regarding the duties of the general partner, the Court affirmed that the general partner was required to make at least some effort to oversee the fund in order to properly discharge its duties of oversight. See Forsythe, 2007 WL 2982247, at * 7 (referring to the terms of the agreement that impose a duty of oversight on the general partner to take active steps to satisfy itself that the person to whom it delegated its authority actually discharged their powers loyally to the fund and in conformity with the agreement).
The governance structure of the fund based on the applicable agreement allowed for the investment decisions on day-to-day management to be delegated to conflicted representatives of an affiliated fund. That structure required greater vigilance by the general partner. If the general partners acted in a manner analogous to an independent director, that may have validated the actions of a conflicted delegate’s decision, but, as the Court explained, the “general partner’s disappearance from the scene and its studious impersonation of a rubber stamp eliminate my ability to rely on the Individual Defendants as a cleansing device.”
The majority of the 33-page decision focuses on the implications of the controlling terms of the agreements among the parties and the nature of the factual issues precluding a ruling on most of the Motion for Summary Judgment. The Court also devotes a fair amount of time to “clearing out the underbrush so the parties can focus at trial on the major disputes.” At trial, the acts and omissions of the defendants will be measured by the standards defined in the agreements among the parties and whether or not those acts or omissions constituted bad faith, willful misconduct of gross negligence.